There is a big difference between an escrow contract and a trust contract. In the escrow contract one party places certain funds in the hands of the escrow company for a variety of purposes, such as: a means to show good faith and real intent to purchase a property or some other important item. Those funds can be an initial earnest money deposit, which is a small portion of the total price, with the purpose of locking in the price of the transaction and having a privileged position to purchase.
The initial deposit can be anywhere from 3% (the usual custom in the USA) to 10% (the usual custom here in Costa Rica, but still just a custom that can be negotiated). This type of contract can have an important practical use in places where there is a large demand for property and the buyer must lock the price in before it increases or he loses the property to another buyer. Escrow contracts can be used for many different purposes, not only property purchases.
A contract of trust is also the granting of funds to a third-party individual or company but for an ongoing situation or legal relationship. A trust can be established to ensure income for a third party to be given in monthly or yearly amounts. For example, a parent or grandparent that sets up a trust for their children, so they don’t transfer all the wealth all at once. A trust is a much more complex contract as it involves more people and usually entails an ongoing legal relationship or process.
In this article we will concentrate on the escrow contract and we will comment on the trust in a future contribution.
The escrow contract is a legal custom of the Anglo-American Common Law System and in Costa Rica it is not recognized as such under that name. This process, in which the “buying party” deposits a small percentage of the total price over to the “selling party” or an impartial third party in order to have the time to do the due diligence (an investigation into important aspects of the property such as: the title, the rights upon the property, the physical condition of the property and many others), to reserve the property and lock in the price, is very much recognized in Costa Rica law (Roman Civil Law) but it has important differences and caveats from the common law system that can be crucial or devastating to either party.
In Costa Rica it is commonly called a “señal de trato” which means a sign of good faith to do the deal and it is regulated in the Civil and Commercial Codes and these laws state that the amounts given as an initial deposit are PRESUMED TO BE PART OF THE PRICE unless the parties clearly state that it is not.
This means that if the buying party hands over an initial deposit to the selling party, then the property or item has BEEN SOLD/BOUGHT unless the parties clearly indicate that this amount is only a sign of good faith and not a part of the price. This is important if the deposit is given to the escrow company to hold.
The main problem when transferring funds over to an escrow company is the financial health of that escrow. What happens if the escrow company somehow loses the funds that the buying party has handed over for the initial deposit or, even worse, the total amount of the price? What happens if the escrow company pays before it should? What happens if the escrow company does not comply with the buyer’s instructions on some important issue?
There is an important case in Costa Rica jurisprudence in which the buying party paid the initial deposit for an important property and started to do their due diligence. The buying party was eager to purchase the property and the seller was eager to sell. The property had a court annotation that needed to be lifted before the property could be transferred to the buyer.
The seller, wanting to move the deal along, allowed the buyer to move into the property and deposit the rest of the price with the escrow company until the annotation was lifted, which would take several months. At that point, the escrow company was defrauded internally and the funds disappeared. The question now was who would suffer the consequences of the money being stolen. The escrow company had no assets that could be attached as satisfaction of recovery.
The seller asked the court to evict the buyer from the property because, in the seller’s opinion, the sale had not gone through and they also requested that the court restore their possession arguing that they had not received the funds “in their hands” and that the loss should be suffered by the buyer. The buying party argued the exact opposite position.
The court, in its decision, found for the buyer and against the seller. The court said that once the seller allowed the buyer to move into the property and pay the rest of the purchase price, the contract went from an option to buy and sell the property, to an actual purchase. The seller would have to suffer the loss of the funds because the money deposited with the escrow company belonged to the seller and so the seller had to seek redress from the escrow company which was now bankrupt and had no valuable assets. The price of the property was $500,000.00.
In Costa Rica there is a basic principle of contract law which states that “the agreement is perfected once both parties have agreed on the item being sold and its price”. The rest is a matter of details. This means that in case of a legal dispute, the courts will try to determine if the real “intent” of the parties was to Buy/Sell or if the that final agreement had not yet been reached.
Another important contract principle is that the owner of the item is the one that must suffer or gain from what happens to the item of property and that means that it is critical to be able to determine who is the owner of the property or the item at any given time. This means that, legally speaking, a person can agree to sell a property without knowing fully that they have indeed agreed to that and if, as in the example case, the money is lost, then the seller will suffer the loss.
Usually the buyer does not have that danger because the buyer has not paid the full price yet, but in the event that the buyer has indeed transferred the funds to the escrow company and then wishes to withdraw from the deal, he or she may find themselves in the situation that they have already made the purchase and are now stuck with a property they no longer want.
It is not uncommon for potential buyers from North America or other countries to be presented with escrow contracts that are based on the American or English Common Law Legal System. This makes it easier for them to understand the wording and it makes them feel more comfortable, but this can be a serious mistake because the legal requirements for Costa Rica contract law may not have been met.
In a particular negotiation it can be quite common for all parties involved to be impatient to “close” the deal. The seller obviously wants to receive his money, the buyer wants the property transferred over to him/her and the brokers want to earn their fees, including the lawyers. This eagerness should never be the reason for rushing the process with informal documents and less than perfect handlers of the funds for the clients.
The regulatory framework for escrow companies or individuals varies from country to country. For example in the U.S.A., there is a state by state regulation. Common requirements in the USA include: Forming a corporation (some states only allow corporations to function as escrow agents); you usually must get a state issued license which often requires background checks, fingerprints, exams and experience; It is sometimes necessary to post a surety bond and meet minimum net worth reserves and there are ongoing audits and compliances.
In Costa Rica there is no specific regulation of “escrow” companies, rather there is a general regulation for “companies dedicated to financial services that are not banks”. These companies require a minimum net worth of 3,424,000 million colones or about $7,000.00 which is a low threshold when you consider the amounts of money these companies may handle.
These companies are subject to a number of conditions and requirements and the most basic requirement is that they be registered with SUGEF which is the General Superintendent of Financial Entities. This government office oversees banks and many other financial institutions, including companies dedicated to escrow services.
The buyer should make sure that the entity to whom he is transferring his money is financially sound and has no possibility of causing him financial harm. For example, is the escrow company insured, do they hold the client´s funds in a separate escrow account, etc. The seller should also make sure that he/she is not signing documents that could put his assets in danger.
This can be difficult because at the beginning of negotiations there is usually a lot of trust between the parties and everything seems great but as the negotiation goes on and problems start to arise that trust is no longer there and only well-prepared documentation can ensure the success of an important negotiation.
About
Lic. Jorge Montero B. is an attorney and Notario Público educated in the U.S.A. and in Costa Rica. He holds various Post Graduate Degrees in Criminal, Commercial, Environmental and Agrarian Law from the University of Costa Rica and has over 30 years of litigation, contract and counsel experience.
Email: acmbalaw@gmail.com
Tel: (506)- 8384- 2246
WhatsApp: (506) 8384- 2246
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